Expect Gold Ore Price Index to Grow at Lower Rate than PPI

Previously, we have demonstrated that gold ores price can be predicted at a several year horizon [1]. The prediction was based on the observation that the difference between the overall producer price index, PPI, and the producer index for gold ores shows sustainable trends. A new trend has been emerging since 2008 and the difference can be foreseen at a five to ten-year horizon. As the PPI will be likely constant over the next decade, the difference provides a direct prediction of the price index for gold ores. In this article, we update the forecast using a new reading of the PPI for June 2009.

Currently, the US economy is struggling through a period of high volatility in all macroeconomic variables including the difference between various PPI subcategories and commodities. Figure 1 illustrates the observation that this volatile period is related to the turn to a new trend in the difference after 2008. We have made a naïve assumption about the new trend shown by green line - it should repeat the trend observed between 2001 and 2008 but with an opposite sign. Actual trend may be different but inevitably with a positive slope. The green line has a positive slope. Therefore the index for gold ores will be growing at a lower rate than the overall PPI. According to our assumption, the rate of the deviation from the PPI will be +11 units of index per year.

Why do these turns to new trends happen at all? This is a right question. Some differences between CPI components did not show any turn since the earlier 1980s. For example, the index for medical care deviates from the headline CPI at an almost constant rate [2]. The index for higher education has been running away with acceleration. The PPI for chemicals did show such behavior [3]. However, many differences have been rather oscillating around some constant level than deviating at a constant rate. Economically, long-term sustainable trends in the differences could be explained by a constant disparity in pricing power. If one industry has an advantage in priding, the advantage might last several years before the opponent will invent a proper counteraction. When invented, these new means can change the pricing power disparity and break the trend. This is not a quantitative explanation, however, and it does not pretend to be right or even instructive. More important are actual observations of the trends, which can be used for the prediction of various price indices.

Figure 1. Evolution of the difference between the PPI and the price index for gold ores between July 1985 and June 2009. Red and blue lines highlight segments between 1988 and 2001, and from 2001 to 2008, respectively. Green line predicts the evolution of the difference after 2008, as a mirror reflection of the linear trend between 2001 and 2008.

We will continue reporting on the long-term prediction, i.e. on the evolution of the difference between the PPI and the index for gold ores. This is an ongoing task which does not need monthly updating. However, it is of interest to look into the short-term behavior of the difference and evaluate the index for gold ores at a several months horizon, as we reported for crude petroleum.

Figure 2 displays the trajectory of the difference since 2005. A characteristic feature is the presence of low-amplitude and high-frequency (monthly) oscillations in the curve since 2006. Bearing in mind the absence of such oscillation if the difference between the PPI and the index of crude petroleum mentioned above, the cause of the oscillations is not clear. In any case, this is a feature, which should be taken into account when predicting gold ores price at time horizons of several months. The reading for June supports the importance of the high-frequency oscillations – the curve, which was expected to go upwards to intersect the new trend in 2009, suffers a local decline. It would be an unusual behavior for the index of crude oil, but it is normal for the index of gold ores.

Despite many local deviations in the past, the curve always returned to the trends. Therefore, the larger is the deviation the bigger should be a countermovement. Accordingly, one can expect that the index for gold ores will soon accelerate to the new trend shown by red line in Figure 2. In other words, the increase in gold price in May and June (and likely in July) should be compensated by an opposite move of the curve to the level above the red trend line. As a result, the index price should fall by ~50 units, i.e. to the level between 180 and 2000, which was observed between April 2006 and August 2007.

Apparently, the prediction is based on the assumption of a natural (in physical sense) behavior of the difference, as has been observed since 1985. The forces behind such behavior are prone to secular changes and there is a non-zero probability that the new trend will never emerge. In any case, we are going to continue reporting on the evolution of the difference.

Figure 2. Evolution of the difference between the PPI and the price index for gold ores between January 2005 and June 2009. Red line predicts the evolution of the difference after 2008. Red circles represent the difference between April and June 2009. We expect the difference will start growing in July-August 2009.

References
[1] Kitov, I., (2009). Predicting gold ores price, MPRA Paper 15873, University Library of Munich, Germany, http://mpra.ub.uni-muenchen.de/15873/01/MPRA_paper_15873.pdf

[2] Kitov, I., Kitov, O., (2008). Long-Term Linear Trends In Consumer Price Indices, Journal of Applied Economic Sciences, Spiru Haret University, Faculty of Financial Management and Accounting Craiova, vol. 3(2(4)_Summ), pp. 101-112. http://www.jaes.reprograph.ro/articles/Kitov.pdf

[3] Kitov, I., Kitov, O., (2009). Sustainable trends in producer price indices, MPRA Paper 15194, University Library of Munich, Germany, http://mpra.ub.uni-muenchen.de/15194/01/MPRA_paper_15194.pdf

Disclosure: no positions

Comments

[DONE_SONZ]

PPI is another thing to watch, is one thing.Using it to guage prices by itself is another.

2009 Jul 17 07:58 AM

[Vuke]

The PPI for gold is going to vary wildly, for political, environmental and energy cost reasons. The assumptions, therefore, are unfounded.

2009 Jul 17 08:58 AM

[Ivan Kitov]

When all these factors do influence gold ores price, why do we observe sustainable trends in Figure 1? I would assume that the net force behind the price is rather constant than volatile. Although, with some fluctuations.


On Jul 17 08:58 AM Vuke wrote:

> The PPI for gold is going to vary wildly, for political, environmental
> and energy cost reasons. The assumptions, therefore, are unfounded.

2009 Jul 17 09:10 AM

[Vuke]

Political, environmental and energy requirements are in flux. Gold is now seen as a desirable political asset, hence higher royalties and fees are extracted. Energy costs are a huge input, inescapable from petrol costs, higher wages are expected from what is regarded as "easy money" and environmentalists are demanding far more extensive closing costs.

In addition, the growing expectation of a "social licence" (community benefits) and the increasing scarcity of high grade ore is a wild card to be factored in. All told, the costs of gold exploration and mining are going to escalate rapidly whereas in previous decades of disinterest all these were non-factors.

A balance will eventually be struck between higher prices and higher costs that will result in an inflexion point in your future projects. Otherwise the concept is sound, gold will stabilize, at a higher price.


On Jul 17 09:10 AM Ivan Kitov wrote:

> When all these factors do influence gold ores price, why do we observe
> sustainable trends in Figure 1? I would assume that the net force
> behind the price is rather constant than volatile. Although, with
> some fluctuations.

2009 Jul 17 09:43 AM

[Maxe Paul]

Ivan, so going off the evidence you present it would be fair to say gold will peak over the next several months before starting a longer term bearish downturn?

Or would it be appropriate to say the indicators point to a lower price but we are seeing an overshoot on the upside?

2009 Jul 17 09:46 AM

[Ivan Kitov]

I would estimates the probability of a much larger peak in July-August as a low one, but still non-zero. Then, the price index should go down in absolute terms oscillating around the new (red in Figure 2) trend. Currently, the price is likely neat its peak of "an overshoot on the upside". For me, it would be natural if the curve will go upwards at an accelerating rate, as one can observe with crude oil.
This is an assumption, however. If Vuke is right, everything will change at once. Nobody denies that the Universe has its start and end. Why not gold to break old bounds.

On Jul 17 09:46 AM Maxe Paul wrote:

> Ivan, so going off the evidence you present it would be fair to say
> gold will peak over the next several months before starting a longer
> term bearish downturn?
>
> Or would it be appropriate to say the indicators point to a lower
> price but we are seeing an overshoot on the upside?

2009 Jul 17 09:55 AM